i.4.2.7 Decision #7 – Evaluate municipal market opportunities to use debt financing

Debt products customarily issued in the municipal market tend to be structured to meet the investment preference of particular investors. The market for debt products sold by state and local governments is highly stratified and is arranged around three factors: (1) the term of the debt obligation, (2) the inherent credit strength of its source of repayment, and (3) the strength of the debt covenants. Debt products range from those with very short maturities (such as commercial paper that can be issued with very short maturities—as short as 1 day) to relatively long maturities (such as long term, fixed rate bonds that can be generally issued with up to 30-year maturities or longer). Some debt products inherently require support from a commercial bank (such as variable-rate demand bonds, which require a line of credit from a commercial bank to cover bonds that investors tender, or essentially sell back to the public agency), while some debt products have no support from commercial banks (such as fixed rate bonds). Some debt products have very few or no financial and operating covenants (other than very basic covenants) while other debt products contain extensive and complex financial and operating covenants that restrict the issuer.

The principal concern of all investors is whether or not the issuer will pay back the debt but they may also seek out specific characteristics, including the following:

FIXED-RATE OR VARIABLE-RATE – Some investors look for fixed rate debt products. Retail investors, for example, want to purchase debt products that will produce a predictable stream of income and that they can place in their investment portfolio for an intermediate-to-long term. Other investors look for variable-rate debt products that may meet specific limitations imposed by policy or financial goals, including liquidity or hedges against a fixed rate position.

LONG-TERM, MEDIUM-TERM, OR SHORT-TERM PRODUCTS – Some investors look for long term debt products that will likely remain outstanding for a long period. Many bond funds generally fall into this category. Retail investors seek medium term investments. Still other investors look for short term debt products. These include bond funds that concentrate on short term variable rate debt.

REDEMPTION PROVISIONS – If investors are looking for a long term, fixed rate debt product, they tend to care about when and at what price the bonds can be redeemed. If investors are looking for short term variable rate debt, they tend not to care about whether the issuer can redeem the debt product because they are less interested in how long the debt product is outstanding.

FINANCIAL COVENANT PACKAGE – Investors of all types consider the financial covenants that may address the issuer’s right to issue additional debt or to maintain a debt service reserve.